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Federated Investors 10-Q 2010

Documents found in this filing:

  1. 10-Q
  2. Ex-2.1
  3. Ex-31.1
  4. Ex-31.2
  5. Ex-32
  6. Ex-32
Form 10-Q
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2010

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number 001-14818

 

 

Federated Investors, Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Pennsylvania   25-1111467

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

Federated Investors Tower

Pittsburgh, Pennsylvania

  15222-3779
(Address of principal executive offices)   (Zip Code)

(Registrant’s telephone number, including area code) 412-288-1900

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨.

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨.

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x.

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the last practicable date: As of October 28, 2010, the Registrant had outstanding 9,000 shares of Class A Common Stock and 102,916,567 shares of Class B Common Stock.

 

 

 


Table of Contents

 

Table of Contents

 

 

             Page No.  
  Part I. Financial Information   
 

Item 1.

 

Financial Statements

  
   

Consolidated Balance Sheets

     3   
   

Consolidated Statements of Income

     4   
   

Consolidated Statements of Changes in Equity

     5   
   

Consolidated Statements of Cash Flows

     6   
   

Notes to the Consolidated Financial Statements

     7   
 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     23   
 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

     43   
 

Item 4.

 

Controls and Procedures

     44   
  Part II. Other Information   
 

Item 1.

 

Legal Proceedings

     45   
 

Item 1A.

 

Risk Factors

     46   
 

Item 2.

 

Unregistered Sales of Equity Securities and Use of Proceeds

     47   
 

Item 6.

 

Exhibits

     48   

Signatures

     49   

Special Note Regarding Forward-Looking Information

 

Certain statements in this report on Form 10-Q including those related to asset flows and business mix; obligations to make additional contingent payments pursuant to acquisition agreements; the timing of acquisition related closings; obligations to make additional payments pursuant to employment agreements; the costs associated with the settlement with the Securities and Exchange Commission and the New York State Attorney General; legal proceedings; future cash needs and management’s expectations regarding liquidity and borrowing; future principal uses of cash; performance indicators; impact of accounting policies and new accounting pronouncements; concentration risk; indemnification obligations; the impact of increased regulation (including the possible impact of recent amendments to Rule 2a-7 of the Investment Company Act of 1940); the prospect of increased distribution-related expenses; management’s expectations regarding fee waivers and the impact of such waivers on revenues and net income; the ability to raise additional capital; the rising costs of risk management; possible impairment charges; tax liability; capital losses; the impact of the interest rate swap and the various items set forth under the section entitled Risk Factors constitute forward-looking statements, which involve known and unknown risks, uncertainties, and other factors that may cause the actual results, levels of activity, performance or achievements of Federated or industry results, to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Among other risks and uncertainties, market conditions may change significantly resulting in changes to Federated’s asset flows and business mix, which may cause a decline in revenues and net income, result in impairments and increase the amount of fee waivers incurred by Federated. The obligation to make contingent payments is based on certain growth and fund performance targets and will be affected by the achievement of such targets, and the obligation to make additional payments pursuant to employment agreements is based on satisfaction of certain conditions set forth in those agreements. Future cash needs and future uses of cash will be impacted by a variety of factors, including the number and size of any acquisitions, Federated’s success in distributing its products, the resolution of pending litigation, potential increases in costs relating to risk management, as well as potential changes in assets under management and/or changes in the terms of distribution and shareholder services contracts with intermediaries who offer Federated’s products to customers. Federated’s risks and uncertainties also include liquidity and credit risks in Federated’s money market funds and revenue risk, which will be affected by yield levels in money market fund products, changes in market values of assets under management, the ability of Federated to collect fees in connection with the management of such products. Many of these factors may be more likely to occur as a result of the ongoing threat of terrorism and the increased scrutiny of the mutual fund industry by federal and state regulators, and the recent and ongoing disruption in global financial markets. As a result, no assurance can be given as to future results, levels of activity, performance or achievements, and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future. For more information on these items, see the section entitled Risk Factors herein under Item 2 of Part I, Management’s Discussion and Analysis of Financial Condition and Results of Operations.


Table of Contents

 

Part I, Item 1. Financial Statements

Consolidated Balance Sheets

 

(dollars in thousands)

(unaudited)

 

     September 30,
2010
    December 31,
2009
 

ASSETS

    

Current Assets

    

Cash and cash equivalents

   $ 222,684      $ 90,452   

Investments

     93,226        31,538   

Receivables – affiliates

     10,846        11,490   

Receivables – other, net of reserve of $123 and $200, respectively

     9,711        8,144   

Prepaid expenses

     13,617        27,090   

Current deferred tax asset, net

     2,031        11,166   

Other current assets

     5,167        4,907   
                

Total current assets

     357,282        184,787   
                

Long-Term Assets

    

Goodwill

     609,753        581,673   

Customer-related intangible assets, net of accumulated amortization of $109,781 and $100,710, respectively

     85,258        71,959   

Other intangible assets, net of accumulated amortization of $8,494 and $6,932, respectively

     6,243        9,364   

Deferred sales commissions, net of accumulated amortization of $55,981 and $50,018, respectively

     11,228        15,318   

Property and equipment, net of accumulated depreciation of $40,423 and $35,541, respectively

     38,315        40,027   

Other long-term assets

     11,063        9,305   
                

Total long-term assets

     761,860        727,646   
                

Total assets

   $ 1,119,142      $ 912,433   
                

LIABILITIES

    

Current Liabilities

    

Short-term debt – recourse

   $ 42,500      $ 21,000   

Accounts payable and accrued expenses

     47,566        50,404   

Accrued compensation and benefits

     53,013        64,387   

Other current liabilities

     51,173        61,207   
                

Total current liabilities

     194,252        196,998   
                

Long-Term Liabilities

    

Long-term debt – recourse

     371,875        105,000   

Long-term debt – nonrecourse

     6,639        13,556   

Long-term deferred tax liability, net

     38,226        39,234   

Other long-term liabilities

     34,787        14,917   
                

Total long-term liabilities

     451,527        172,707   
                

Total liabilities

     645,779        369,705   
                

Commitments and contingencies (Note (16))

    

TEMPORARY EQUITY

    

Redeemable noncontrolling interests in subsidiaries

     19,611        13,913   
                

PERMANENT EQUITY

    

Federated Investors shareholders’ equity

    

Common stock:

    

Class A, no par value, 20,000 shares authorized, 9,000 shares issued and outstanding

     189        189   

Class B, no par value, 900,000,000 shares authorized, 129,505,456 shares issued

     232,532        216,820   

Additional paid-in capital from treasury stock transactions

     153        0   

Retained earnings

     1,025,967        1,105,073   

Treasury stock, at cost, 26,597,889 and 26,571,219 shares Class B common stock, respectively

     (795,735     (795,389

Accumulated other comprehensive (loss) income, net of tax

     (9,846     1,514   
                

Total Federated Investors, Inc. shareholders’ equity

     453,260        528,207   

Nonredeemable noncontrolling interest in subsidiary

     492        608   
                

Total permanent equity

     453,752        528,815   
                

Total liabilities, temporary equity and permanent equity

   $ 1,119,142      $ 912,433   
                

(The accompanying notes are an integral part of these Consolidated Financial Statements.)

 

3


Table of Contents

 

Consolidated Statements of Income

 

(dollars in thousands, except per share data)

(unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2010     2009     2010     2009  

Revenue

        

Investment advisory fees, net-affiliates

   $ 148,051      $ 174,861      $ 428,364      $ 531,721   

Investment advisory fees, net-other

     15,732        15,151        45,866        42,517   

Administrative service fees, net-affiliates

     53,085        65,267        161,233        199,726   

Other service fees, net-affiliates

     21,788        34,374        60,160        125,122   

Other service fees, net-other

     2,857        2,583        8,821        7,752   

Other, net

     660        1,367        2,182        4,302   
                                

Total revenue

     242,173        293,603        706,626        911,140   
                                

Operating Expenses

        

Distribution

     68,800        95,911        190,068        333,301   

Compensation and related

     61,387        62,232        186,469        192,068   

Professional service fees

     9,401        10,089        9,596        29,873   

Office and occupancy

     5,841        6,001        16,990        18,315   

Systems and communications

     5,362        6,058        16,996        17,871   

Advertising and promotional

     2,724        2,529        7,480        8,238   

Travel and related

     2,692        2,316        8,005        7,631   

Intangible asset impairment and amortization

     3,397        3,953        16,522        28,665   

Amortization of deferred sales commissions

     2,987        5,104        9,274        14,936   

Other

     4,494        4,677        14,467        17,396   
                                

Total operating expenses

     167,085        198,870        475,867        668,294   
                                

Operating income

     75,088        94,733        230,759        242,846   
                                

Nonoperating Income (Expenses)

        

Investment income, net

     1,049        233        2,058        789   

Gain on securities, net

     3,426        1,452        835        1,704   

Debt expense – recourse

     (4,958     (1,112     (10,196     (3,370

Other, net

     (65     (415     (310     (1,161
                                

Total nonoperating (expenses) income , net

     (548     158        (7,613     (2,038
                                

Income before income taxes

     74,540        94,891        223,146        240,808   

Income tax provision

     26,477        34,604        82,613        86,970   
                                

Net income including noncontrolling interests in subsidiaries

   $ 48,063      $ 60,287      $ 140,533      $ 153,838   
                                

Less: Net income attributable to noncontrolling interests in subsidiaries

     5,007        3,301        7,820        8,444   
                                

Net income

   $ 43,056      $ 56,986      $ 132,713      $ 145,394   
                                

Amounts attributable to Federated Investors, Inc.

        

Earnings per common share – Basic and Diluted

   $ 0.42      $ 0.56      $ 1.27      $ 1.42   
                                

Cash dividends per share

   $ 0.24      $ 0.24      $ 1.98      $ 0.72   
                                

(The accompanying notes are an integral part of these Consolidated Financial Statements.)

 

4


Table of Contents

 

Consolidated Statements of Changes in Equity

 

(dollars in thousands)

(unaudited)

 

    Federated Investors, Inc. Shareholders                    
    Common Stock     Additional Paid-in
Capital from
Treasury Stock
Transactions
    Retained Earnings     Treasury Stock     Accumulated
Other
Comprehensive
(Loss) Income,
Net of Tax
    Total
Shareholders’
Equity
    Nonredeemable
Noncontrolling
Interest in
Subsidiary
    Total Permanent
Equity
    Redeemable
Noncontrolling
Interests in
Subsidiaries/
Temporary Equity
 

Balance at December 31, 2008

  $ 198,630      $ 0      $ 1,028,928      $ (804,481   $ 297      $ 423,374      $ 417      $ 423,791      $ 779   

Net Income

    0        0        145,394        0        0        145,394        7,089        152,483        1,355   

Other comprehensive income, net of tax:

                 

Unrealized gain, net of reclassification adjustment1

    0        0        (132     0        777        645        0        645        0   

Foreign currency translation2

    0        0        0        0        629        629        0        629        62   
                                                                       

Comprehensive Income3

              146,668        7,089        153,757     
                                   

Subscriptions – redeemable noncontrolling interest holders

    0        0        0        0        0        0        0        0        7,105   

Deconsolidation

    0        0        0        0        0        0        0        0        (423

Stock award activity

    12,940        (79     (11,158     11,548        0        13,251        0        13,251        0   

Dividends declared/Distributions to noncontrolling interest in subsidiaries

    0        0        (73,650     0        0        (73,650     (7,023     (80,673     (130

Exercise of stock options

    606        79        (2,133     6,440        0        4,992        0        4,992        0   

Purchase of treasury stock

    0        0        0        (18,806     0        (18,806     0        (18,806     0   
                                                                       

Balance at September 30, 2009

  $ 212,176      $ 0      $ 1,087,249      $ (805,299   $ 1,703      $ 495,829      $ 483      $ 496,312      $ 8,748   
                                                                       

Balance at December 31, 2009

  $ 217,009      $ 0      $ 1,105,073      $ (795,389   $ 1,514      $ 528,207      $ 608      $ 528,815      $ 13,913   

Net Income

    0        0        132,713        0        0        132,713        7,420        140,133        400   

Other comprehensive loss, net of tax:

                 

Unrealized loss, net of reclassification adjustment1

    0        0        16        0        (11,057     (11,041     0        (11,041     0   

Foreign currency translation2

    0        0        0        0        (303     (303     0        (303     (35
                                                                       

Comprehensive Income3

              121,369        7,420        128,789     
                                   

Subscriptions – redeemable noncontrolling interest holders

    0        0        0        0        0        0        0        0        7,467   

Stock award activity

    15,472        0        (8,283     8,283        0        15,472        0        15,472        0   

Dividends declared/Distributions to noncontrolling interest in subsidiaries

    0        0        (203,423     0        0        (203,423     (7,536     (210,959     (2,134

Exercise of stock options

    240        153        (129     660        0        924        0        924        0   

Purchase of treasury stock

    0        0        0        (9,289     0        (9,289     0        (9,289     0   
                                                                       

Balance at September 30, 2010

  $ 232,721      $ 153      $ 1,025,967      $ (795,735   $ (9,846   $ 453,260      $ 492      $ 453,752      $ 19,611   
                                                                       

(The accompanying notes are an integral part of these Consolidated Financial Statements.)

 

1

The tax benefit (expense) on the reclassification adjustment, net of unrealized gain/loss was $5,771 and ($429) for the nine months ended September 30, 2010 and 2009, respectively.

2

The tax benefit (expense) on the foreign currency translation was $163 and ($339) for the nine months ended September 30, 2010 and 2009, respectively.

3

Comprehensive income for Total Shareholders’ Equity, Nonredeemable Noncontrolling Interest in Subsidiary and Total Permanent Equity was $42,879, $2,446 and $45,325, respectively, for the three months ended September 30, 2010. Comprehensive income for Total Shareholders’ Equity, Nonredeemable Noncontrolling Interest in Subsidiary and Total Permanent Equity was $57,570, $2,436 and $60,006, respectively, for the three months ended September 30, 2009.

 

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Table of Contents

 

Consolidated Statements of Cash Flows

 

(dollars in thousands)

(unaudited)

 

Nine Months Ended September 30,

   2010     2009  

Operating Activities

    

Net income including noncontrolling interests in subsidiaries

   $ 140,533      $ 153,838   

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities

    

Amortization of deferred sales commissions

     9,274        14,936   

Depreciation and other amortization

     16,074        17,947   

Impairment of assets

     6,956        21,163   

Share-based compensation expense

     14,703        14,237   

(Gain) loss on disposal of assets

     (663     381   

Provision (benefit) for deferred income taxes

     14,003        (9,793

Tax benefit (detriment) from share-based compensation

     1,536        (344

Excess tax benefits from share-based compensation

     (2,702     (954

Net purchases of trading securities

     (3,448     (8,793

Deferred sales commissions paid

     (8,095     (8,744

Contingent deferred sales charges received

     1,761        2,736   

Proceeds from sale of certain B-share-related future revenue

     1,223        3,922   

Other changes in assets and liabilities:

    

(Increase) decrease in receivables, net

     (885     9,516   

Decrease in prepaid expenses and other assets

     14,426        635   

Decrease in accounts payable and accrued expenses

     (17,203     (15,937

Increase in income taxes payable

     1,079        1,479   

(Decrease) increase in other liabilities

     (17,581     4,507   
                

Net cash provided by operating activities

     170,991        200,732   
                

Investing Activities

    

Purchases of securities available for sale

     (58,202     (1,283

Cash paid for business acquisitions

     (46,127     (24,079

Cash paid for property and equipment

     (5,126     (9,964

Cash paid for purchased loans

     (44,343     0   

Proceeds from disposal of property and equipment

     3,298        0   

Proceeds from redemptions of securities available for sale

     45,402        1   
                

Net cash used by investing activities

     (105,098     (35,325
                

Financing Activities

    

Dividends paid

     (203,951     (73,912

Purchases of treasury stock

     (9,289     (18,806

Distributions to noncontrolling interest in subsidiaries

     (9,670     (7,153

Contributions from noncontrolling interest in subsidiaries

     7,467        6,686   

Proceeds from shareholders for share-based compensation

     683        4,697   

Excess tax benefits from share-based compensation

     2,702        954   

Proceeds from new borrowings – recourse

     407,000        54,800   

Proceeds from new borrowings – nonrecourse

     271        861   

Payments on debt – recourse

     (118,625     (102,371

Payments on debt – nonrecourse

     (7,383     (15,600

Other

     (2,866     0   
                

Net cash provided (used) by financing activities

     66,339        (149,844
                

Net increase in cash and cash equivalents

     132,232        15,563   

Cash and cash equivalents, beginning of period

     90,452        45,438   
                

Cash and cash equivalents, end of period

   $ 222,684      $ 61,001   
                

(The accompanying notes are an integral part of these Consolidated Financial Statements.)

 

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Table of Contents

 

Notes to the Consolidated Financial Statements

 

(Unaudited)

(1) Basis of Presentation

The interim consolidated financial statements of Federated Investors, Inc. and its subsidiaries (collectively, Federated) included herein have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). In the opinion of management, the financial statements reflect all adjustments that are of a normal recurring nature and necessary for a fair presentation of the results for the interim periods presented.

In preparing the financial statements, management is required to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Actual results may differ from such estimates, and such differences may be material to the Consolidated Financial Statements.

These financial statements should be read in conjunction with Federated’s Annual Report on Form 10-K for the year ended December 31, 2009. Certain items previously reported have been reclassified to conform to the current period’s presentation.

(2) Summary of Revised Significant Accounting Policies

Included below are excerpts of Federated’s significant accounting policies that have been revised in 2010. For a complete listing of Federated’s significant accounting policies, please refer to Federated’s Annual Report on Form 10-K for the year ended December 31, 2009.

(a) Principles of Consolidation for Variable Interest Entities

Beginning on January 1, 2010, Federated adopted the provisions of the Financial Accounting Standards Board’s (FASB) new consolidation model for variable interest entities (VIEs). As a result, Federated applies two different approaches to consider VIEs for possible consolidation. For non-investment fund entities, Federated considers a qualitative model for identifying whether its interest in a VIE is a controlling financial interest. The qualitative model considers whether Federated has: (1) the power to direct significant activities of the VIE, and (2) the obligation to absorb losses of and/or to provide rights to receive benefits from the VIE that could potentially be significant to the VIE. Federated reevaluates the need for consolidation under this qualitative approach on an ongoing basis.

For Federated’s interests in certain investment funds that meet the definition of VIEs, Federated evaluates the extent of Federated’s participation in the economic risks and rewards of the entity based on a quantitative model to determine whether consolidation is necessary. In cases where the results of the quantitative model indicate that Federated’s interest in such an entity absorbs the majority of the variability in the entity’s net assets, Federated is deemed to be the primary beneficiary and thus consolidates the entity.

(b) Deferred Sales Commissions – Self Financing

Federated began self-funding the sale of Class B shares of its sponsored mutual funds in March 2010. Accordingly, Federated capitalizes the upfront commissions related to these B-share sales as deferred sales commissions. The deferred sales commission asset is amortized over the estimated period of benefit of up to eight years. Distribution and shareholder service fees earned are recognized in the Consolidated Statements of Income over the life of the mutual fund share class. Contingent deferred sales charges collected on these share classes are used to reduce the deferred sales commission asset. As of September 30, 2010, Federated has funded $3.7 million in deferred sales commissions.

(c) Cash Flow Hedge

Federated holds an interest rate swap that qualifies for cash flow hedge accounting. Upon inception of a hedging relationship, Federated formally documents the relationship between the hedging instrument and the hedged item, as well as the risk management objective and the nature of the risk being hedged. To qualify for hedge accounting, the derivative must be deemed to be highly effective in offsetting the designated changes in the cash flows of the hedged item. The effective portions of the change in the fair value of the derivative are reported as a component of Accumulated other comprehensive (loss) income, net of tax on the Consolidated Balance Sheets and subsequently reclassified to earnings in the period or periods during which the hedged transaction affects earnings. The change in fair value of the ineffective portion of the derivative, if any, is recognized immediately in earnings. If it is determined that the derivative instrument is not highly effective, hedge accounting is discontinued. If hedge accounting is discontinued because it is no longer probable that a forecasted transaction will occur, the

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

derivative will continue to be recorded on the balance sheet at its fair value with changes in fair value included in current earnings, and the gains and losses in Accumulated other comprehensive (loss) income, net of tax will be recognized immediately into earnings. If hedge accounting is discontinued because the hedging instrument is sold, terminated or no longer designated, the amount reported in Accumulated other comprehensive (loss) income, net of tax up to the date of sale, termination or de-designation continues to be reported in Accumulated other comprehensive (loss) income, net of tax until the forecasted transaction affects earnings. See Note (7) and Note (12) for additional information on the fair value of the interest rate swap at September 30, 2010.

(d) Purchased Loans

Purchased loans, consisting primarily of syndicated, commercial, US dollar-denominated, floating-rate term loans, are recorded at fair value and included in Other current assets on the Consolidated Balance Sheets. Fair value of a purchased loan is determined using an independent, third-party pricing service that determines fair value based upon obtaining bid and ask prices from potential buyers and sellers. Federated is holding the purchased loans as an investment for current income and elected to use fair-value accounting as of the purchase date of the loans in order to account for the purchased loans in a manner similar to its accounting for trading securities. Interest income, which is calculated based on actual days elapsed in a 360-day year, is recorded in Investment income, net in the Consolidated Statements of Income. Changes in the fair values of purchased loans are recognized in Gain on securities, net in the Consolidated Statements of Income. See Note (7) and Note (10) for additional information on the fair value of the purchased loans held at September 30, 2010.

(3) Recent Accounting Pronouncements

(a) On January 1, 2010, Federated adopted the new requirements for expanded fair-value disclosures as issued by the FASB. The new literature requires disclosures about transfers into and out of Levels 1 and 2 fair value measurements and clarifies existing fair value disclosures about the level of disaggregation and about inputs and valuation techniques used to measure fair value. These new rules impact disclosures only and had no impact on Federated’s financial position or results of operations. The new rules also require additional disclosures regarding Level 3 fair value measurements which are effective for reporting periods beginning after December 15, 2010.

(b) On January 1, 2010, Federated adopted the FASB’s new rules governing the consolidation of VIEs, as amended in February 2010 to defer the effective date of the new rules for a reporting entity’s interests in certain investment funds. The new rules prescribe a qualitative model for identifying whether a company has a controlling financial interest in a VIE and eliminates the quantitative model previously prescribed. The new rules identify two primary characteristics of a controlling financial interest: (1) the power to direct significant activities of the VIE, and (2) the obligation to absorb losses of and/or provide rights to receive benefits from the VIE. Under the new accounting standard, a company is required to reassess on an ongoing basis whether it holds a controlling financial interest in a VIE. A company that holds a controlling financial interest is deemed to be the primary beneficiary of the VIE and is required to consolidate the VIE. The adoption of the new standard did not have a material impact on Federated’s Consolidated Financial Statements.

(c) On January 1, 2010, Federated adopted a new accounting standard regarding accounting for transfers of financial assets that removes the concept of a qualifying special-purpose entity from authoritative guidance and also removes the exception previously under GAAP. This new accounting standard also clarifies the requirements for isolation and limitations on portions of financial assets that are eligible for sale accounting. The adoption of this new accounting standard did not have a material impact on its Consolidated Financial Statements as Federated was not involved with any transactions to transfer financial assets at the time of adoption.

(d) On January 6, 2010, the FASB issued an update to clarify the scope of the decrease-in-ownership provisions of the accounting rules relating to noncontrolling interests. In addition, the update expands the disclosures required upon deconsolidation of a subsidiary. The update is effective immediately for Federated and is expected to only impact future disclosures regarding the deconsolidation of subsidiaries. Management does not expect the adoption of the update to impact Federated’s Consolidated Financial Statements.

(e) On February 24, 2010, the FASB issued an update to address certain implementation issues related to an entity’s requirement to perform and disclose subsequent-events procedures. Effective upon its issuance, the update exempts Securities and Exchange Commission (SEC) filers from disclosing the date through which subsequent events have been evaluated. As the

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

update affected disclosure only, the adoption of the update did not have an impact on Federated’s Consolidated Financial Statements.

(4) Business Combinations and Acquisitions

On September 20, 2010, Federated acquired the money market management business of SunTrust Banks, Inc. (SunTrust Acquisition). Pursuant to the definitive agreement signed on July 16, 2010, $11.0 billion of money market assets transitioned to Federated during the quarter ended September 30, 2010. To date, money market mutual fund assets in nine money market mutual funds managed by SunTrust’s RidgeWorth Capital Management were transitioned into eight existing Federated money market mutual funds with similar investment objectives in connection with the first in a series of closings. Federated expects two more closings to occur in November 2010 to complete the transition.

The transaction includes upfront cash payments that are expected to total up to $7 million, with $4.9 million paid as of September 30, 2010. The transaction also includes contingent purchase price payments payable over five years. The contingent purchase price payments will be calculated as a percentage of revenue less operating expenses directly attributed to certain eligible assets. The contingent payments are not limited by any maximum amount. Based on asset levels of $14.5 billion, the additional payments would total approximately $27 million over five years. The actual amount of the contingent payments will vary based on asset levels and related net revenues. Management is unable to reasonably estimate a range of possible outcomes due to the wide range of possible flow-rate scenarios for the assets under management. The preliminary estimate of fair value of the total estimated consideration is $26.7 million. As of September 30, 2010, a liability of $21.8 million representing the fair value of future consideration payments was recorded in Other long-term liabilities (see Note (7)(a) for a discussion regarding the valuation methodology). This liability will be remeasured at each reporting date and changes in the fair value will be recognized in earnings.

The transaction was accounted for under the acquisition method of accounting. Accordingly, the purchase price was allocated to the intangible assets acquired based upon preliminary estimates of fair values as of the acquisition date. Federated is currently completing its valuation to determine the fair value of the identifiable intangible assets and consideration associated with the SunTrust Acquisition. Although the preliminary results of the valuation are reflected in the Consolidated Financial Statements as of September 30, 2010 and for the three- and nine-month periods ended September 30, 2010 and the related footnotes, the final valuation results may require adjustments to this preliminary valuation and such adjustments may be material. The preliminary valuation results indicate that the purchase price is primarily assignable to a $26.7 million identifiable intangible asset with an indefinite life, which will be deductible for tax purposes.

The results of operations for the SunTrust Acquisition were included in Federated’s Consolidated Financial Statements beginning in September 2010 based on the date of the acquisition. The following table summarizes unaudited pro forma financial information assuming the SunTrust Acquisition occurred at the beginning of the periods presented. This pro forma financial information is for informational purposes only and is not indicative of future results. In addition, the following pro forma financial information has not been adjusted to reflect lower current levels of assets under management:

 

     (pro forma)
Three Months Ended
September 30,
     (pro forma)
Nine Months Ended
September 30,
 

(in millions, except per share data)

   2010      2009      2010      2009  

Revenue

   $ 249.7       $ 305.6       $ 735.4       $ 950.7   

Net income attributable to Federated Investors, Inc.

   $ 45.1       $ 60.4       $ 141.0       $ 157.2   

Earnings per share – Basic and Diluted

           

Net income attributable to Federated Investors, Inc.

   $ 0.44       $ 0.59       $ 1.35       $ 1.53   

The pro forma results include adjustments for the effect of acquisition-related expenses including transaction expenses and income tax expense.

(5) Concentration Risk

As of September 30, 2010, Federated has the following revenue concentrations:

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

Revenue concentration by asset class – Approximately 50% of Federated’s total revenue for the nine months ended September 30, 2010 was attributable to money market managed assets. A significant change in Federated’s money market business or a significant reduction in money market managed assets due to regulatory changes, changes in the financial markets including significant increases in interest rates over a short period of time, significant deterioration in investor confidence, persistent declines in or prolonged periods of historically low short-term interest rates and resulting fee waivers or other circumstances, could have a material adverse effect on Federated’s results of operations.

Through the adverse market conditions of 2008, Federated’s government agency and treasury money market funds experienced significant asset inflows, which drove substantial increases in Federated’s money market managed assets. These funds grew as certain investors favored the perceived safety and liquidity of portfolios backed by government securities over other investment products. In certain products, the gross yield is not sufficient to cover all of the fund’s normal operating expenses. During the fourth quarter 2008, Federated began waiving fees in order for certain funds to maintain positive or zero net yields.

During the nine months ended September 30, 2010, fee waivers to maintain positive or zero net yields totaled $181.6 million and were partially offset by a related reduction in distribution expenses of $139.8 million such that the net impact to Federated was $41.8 million in reduced operating income. The impact of these fee waivers for the nine months ended September 30, 2010 was significantly more than the impact for the nine months ended September 30, 2009 with $63.1 million in waived fees, $43.8 million in reduced distribution expenses and a net impact on operating income of $19.3 million. Management expects the fee waivers and the related reduction in distribution expense will continue for the remainder of 2010 and into 2011 and will likely be material. Assuming current market conditions and asset levels remain constant, fee waivers for the fourth quarter 2010 may result in a net impact on operating income of approximately $11 million to $12 million. Increases in short-term interest rates that result in higher yields on securities purchased in money market fund portfolios would reduce the operating income impact of these waivers. Management is unable to predict the amount of future fee waivers as they are contingent on a number of variables including, but not limited to, available yields on instruments held by the funds, changes in assets within the funds, actions by the Federal Reserve and the U.S. Department of the Treasury, changes in expenses of the funds, changes in the mix of customer assets, and Federated’s willingness to continue the fee waivers.

Revenue concentration by product – Approximately 11% and 12% of Federated’s total revenue for the three and nine months ended September 30, 2010, respectively, was derived from services provided to one sponsored fund (Federated Kaufmann Fund). A significant and prolonged decline in the assets under management in this fund could have a material adverse effect on Federated’s future revenues and, to a lesser extent, net income, due to a related reduction to distribution expenses associated with this fund.

Revenue concentration by customer – Approximately 14% and 13% of Federated’s total revenue for the three and nine months ended September 30, 2010, respectively, was derived from services provided to one intermediary customer, the Bank of New York Mellon Corporation (including its Pershing subsidiary). Significant changes in Federated’s relationship with this customer could have a material adverse effect on Federated’s future revenues and, to a lesser extent, net income, due to related material reductions to distribution expenses associated with this intermediary.

A listing of Federated’s risk factors is included herein under the section entitled Risk Factors under Item 2 of Part I, Management’s Discussion and Analysis of Financial Condition and Results of Operations.

(6) Variable Interest Entities

Federated is involved with various entities in the normal course of business that may be deemed to be voting rights entities or VIEs. In accordance with Federated’s consolidation accounting policy, Federated first determines whether the entity being evaluated is a voting rights entity or a VIE. Once this determination is made, Federated proceeds with its evaluation of whether or not to consolidate the entity. The disclosures below represent the results of such evaluations pertaining to September 30, 2010 and December 31, 2009.

(a) Consolidated Variable Interest Entities

Most of Federated’s sponsored mutual funds meet the definition of a VIE primarily due to the fact that given Federated’s typical series fund structure, the shareholders of each participating portfolio underlying the series fund generally lack the ability as an individual group to make decisions through voting rights regarding the board of directors/trustees of the fund.

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

From time to time, Federated invests in certain of these products for general corporate investment purposes or, in the case of newly launched products, in order to provide investable cash thereby allowing the product to establish a performance history. Federated’s investment in these products represents its maximum exposure to loss. As of September 30, 2010 and December 31, 2009, Federated was the sole or majority investor in certain of these products and was deemed to be the primary beneficiary since Federated’s majority interest would absorb the majority of the variability of the net assets of the VIE. Federated’s conclusion to consolidate a sponsored product may vary from period to period based on changes in Federated’s percentage interest in the product resulting from changes in the number of fund shares held by either Federated or third parties. Given that the products follow investment company accounting, which prescribes fair-value accounting, a deconsolidation generally does not result in gains or losses for Federated. At September 30, 2010, the aggregate assets and liabilities of such entities that Federated consolidated were $25.6 million and $0.4 million, respectively, and Federated recorded $19.6 million to Redeemable noncontrolling interest in subsidiaries on Federated’s Consolidated Balance Sheets. At December 31, 2009, the aggregate assets and liabilities of such entities that Federated consolidated were $22.6 million and $0.5 million, respectively, and Federated recorded $13.9 million to Redeemable noncontrolling interest in subsidiaries on Federated’s Consolidated Balance Sheets. The assets of the products are primarily classified as Investments on Federated’s Consolidated Balance Sheets. The liabilities of the products are primarily classified as Accounts payable and accrued expenses on Federated’s Consolidated Balance Sheets and primarily represent unsettled trades and operating liabilities of the entities. Neither creditors nor equity investors in the products have any recourse to Federated’s general credit. In the ordinary course of business, from time to time, Federated may choose to waive certain fees or assume operating expenses of these products for competitive, regulatory or contractual reasons (see Note (1)(o) of Federated’s Annual Report on Form 10-K for the year ended December 31, 2009). Federated has not provided financial support to any of these products outside the ordinary course of business.

(b) Non-Consolidated Variable Interest Entities

At September 30, 2010 and December 31, 2009, Federated was involved with certain VIEs in which it held a significant variable interest or was the sponsor that held a variable interest, but for which it was not the primary beneficiary. The assets and liabilities of these unconsolidated VIEs and Federated’s maximum risk of loss related thereto were as follows:

 

     As of September 30, 2010      As of December 31, 2009  

in millions

   Unconsolidated
VIE assets
     Unconsolidated
VIE Liabilities
     Total
remaining
carrying value
of investment
and maximum
risk of loss
     Unconsolidated
VIE assets
     Unconsolidated
VIE Liabilities
     Total
remaining
carrying value
of investment
and maximum
risk of loss
 

Sponsored investment funds1

   $ 262,606.0       $ 0       $ 280.5       $ 305,652.4       $ 0       $ 89.2   

Collateralized debt obligations2

   $ 17.3       $ 122.9       $ 0       $ 31.1       $ 127.3       $ 0   

Equity investment

   $ 7.0       $ 2.0       $ 7.5       $ 9.0       $ 4.9       $ 7.6   

 

1

The unconsolidated VIE assets for the sponsored investment products represent total net assets under management for the related products. Of Federated’s $280.5 million invested in these products at September 30, 2010, $214.5 million represents investments in money market products included in Cash and cash equivalents, with the remaining $66.0 million included in Investments on the Consolidated Balance Sheets. Of Federated’s $89.2 million invested in these products at December 31, 2009, $81.6 million represents investments in money market products included in Cash and cash equivalents, with the remaining $7.6 million included in Investments on the Consolidated Balance Sheets.

2

The risk of loss does not reflect any potential loss as a result of a related deferred tax asset expiring unutilized.

Sponsored Investment Funds – Federated acts as the investment manager for certain investment funds that are deemed to be VIEs, as disclosed above. In addition to Federated’s involvement as the investment manager, Federated may also hold investments in these products. Federated is not the primary beneficiary of these VIEs since Federated’s involvement is limited to that of service provider or represents a minority interest in the fund’s assets under management, or both. As a result, Federated’s variable interest is not deemed to absorb the majority of the variability of the entity’s net assets and therefore Federated has not consolidated these entities.

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

In the ordinary course of business, from time to time, Federated may choose to waive certain fees or assume operating expenses of these products for competitive, regulatory or contractual reasons (see Note (1)(o) of Federated’s Annual Report on Form 10-K for the year ended December 31, 2009). Federated has not provided financial support to any of these products outside the ordinary course of business.

Collateralized Debt Obligations (CDOs) – At September 30, 2010 and December 31, 2009, Federated acted as the investment manager for two CDOs with assets under management of $17.3 million and $31.1 million, respectively, that meet the definition of a VIE due primarily to the lack of unilateral decision making authority of the equity holders. These CDOs were not consolidated at September 30, 2010 or December 31, 2009. The CDOs are alternative investment vehicles created for the sole purpose of issuing collateralized debt instruments that offer investors the opportunity for returns that vary with the risk level of their investment. The notes issued by the CDOs are partially collateralized by high yield bonds and had original expected maturities of ten to twelve years. Federated’s variable interests in the CDOs are limited to a 25% equity interest and a fixed, asset-based management fee earned prospectively as services are provided. As an equity holder, Federated participates in all rights and obligations to income and expected losses of the CDOs on a proportionate basis with all other equity holders. In its role as investment manager, Federated is not entitled to any additional residual return nor is it obligated to absorb any expected losses of the entities. Federated has not provided financial support to the CDOs.

Federated is not the primary beneficiary of these VIEs at September 30, 2010 or at December 31, 2009. Upon consideration of the new qualitative model prescribed by the FASB, Federated determined that as of January 1, 2010 and September 30, 2010, neither its equity interest nor its management fee potential could result in Federated receiving benefits or absorbing losses that could potentially be significant to either of these entities. Therefore Federated has not consolidated these entities.

Equity Investment – Federated holds a 12% non-voting, noncontrolling interest in both Dix Hills Partners, LLC, a registered investment adviser and commodity trading adviser, and its affiliate, Dix Hills Associates, LLC (collectively, Dix Hills). Dix Hills is based in Jericho, New York and manages over $1 billion in both absolute return and enhanced fixed-income mandates, including a hedge fund strategy and an enhanced cash strategy. Due primarily to the nature of the voting rights of the equity holders, Dix Hills meets the definition of a VIE, however, with its non-voting 12% interest, Federated is not deemed to have power to direct the activities of Dix Hills and therefore is not the primary beneficiary. Federated has not provided financial support to Dix Hills. Federated’s investment in Dix Hills is included in Other long-term assets on the Consolidated Balance Sheets.

(7) Fair Value Measurements

The FASB defines fair value as the price that would be received to sell an asset or the price paid to transfer a liability on the measurement date. As defined, fair value focuses on the exit price in the principal or most advantageous market for the asset or liability in an orderly transaction between willing market participants. The FASB established a fair value reporting hierarchy to maximize the use of observable inputs and defines the three levels of inputs as follows:

Level 1 – Quoted prices for identical instruments in active markets. Level 1 assets and liabilities may include debt securities and equity securities that are traded in an active exchange market.

Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 inputs may include observable market data such as closing market prices provided by independent pricing services after considering factors such as the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions, indications as to values from dealers and general market conditions. In addition, pricing services may determine the fair value of equity securities traded principally in foreign markets when it has been determined that there has been a significant trend in the U.S. equity markets or in index futures trading. Level 2 assets and liabilities may include debt and equity securities, purchased loans and over-the-counter derivative contracts whose fair value is determined using a pricing model without significant unobservable market data inputs.

Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable in active exchange markets.

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

(a) Fair Value Measurements on a Recurring Basis

The following table presents fair value measurements for classes of Federated’s financial assets and liabilities measured at fair value on a recurring basis:

 

     September 30, 2010
Fair Value Measurements Using
     December 31, 2009
Fair Value Measurements Using
 

(in thousands)

   Level 1      Level 2      Level 3      Total      Level 1      Level 2      Level 3      Total  

Financial Assets

                       

Cash and cash equivalents

   $ 222,684       $ 0       $ 0       $ 222,684       $ 90,452       $ 0       $ 0       $ 90,452   

Available-for-sale equity securities1

     65,995         0         0         65,995         7,591         0         0         7,591   

Trading securities – equity1

     3,594         16,720         0         20,314         4,536         12,966         0         17,502   

Trading securities – debt1

     850         6,067         0         6,917         267         6,178         0         6,445   

Foreign currency forward contract2

     0         232         0         232         0         0         0         0   

Purchased loans3

     0         3,882         0         3,882         0         0         0         0   
                                                                       

Total financial assets

   $ 293,123       $ 26,901       $ 0       $ 320,024       $ 102,846       $ 19,144       $ 0       $ 121,990   
                                                                       

Financial Liabilities

                       

Interest rate swap4

   $ 0       $ 18,380       $ 0       $ 18,380       $ 0       $ 0       $ 0       $ 0   

SunTrust Acquisition future consideration payments liability

     0         0         21,846         21,846         0         0         0         0   

Foreign currency forward contract5

     0         1         0         1         0         154         0         154   
                                                                       

Total financial liabilities

   $ 0       $ 18,381       $ 21,846       $ 40,227       $ 0       $ 154       $ 0       $ 154   
                                                                       

 

1

Amount included in Investments on the Consolidated Balance Sheets.

2

Amount included in Receivables – other on the Consolidated Balance Sheets.

3

Amount included in Other current assets on the Consolidated Balance Sheets. Pricing is determined by a third-party pricing service that determines fair value based on bid and ask prices.

4

Amount included in Other current liabilities on the Consolidated Balance Sheets. Pricing is determined based on a third-party, model-derived valuation in which all significant inputs are observable in active markets including the Eurodollar future rate and yields for three- and thirty-year Treasury securities.

5

Amount included in Accounts payable and accrued expenses on the Consolidated Balance Sheets. Pricing is determined by interpolating a value by utilizing the spot foreign exchange rate and forward points (based on the spot rate and currency interest rate differentials), which are all observable inputs.

The liability for future consideration payments related to the SunTrust Acquisition is recorded at fair value in Other long-term liabilities on the Consolidated Balance Sheet as of September 30, 2010. Management estimated the fair value of future consideration payments related to the SunTrust Acquisition based primarily upon expected future cash flows using an income approach valuation methodology with unobservable market data inputs (Level 3). Such inputs included (1) an estimated rate of change for underlying assets under management based on estimated net redemptions or sales; (2) expected net revenue per managed asset based generally on contract terms; and (3) a discount rate estimated at the current market rate of return.

Federated did not hold material investments in securities that were measured at fair value using significant unobservable market data inputs (Level 3) during the nine months ended September 30, 2010 or year ended December 31, 2009.

Between December 31, 2009 and September 30, 2010, there were no significant transfers between Level 2 and Level 1. From time to time, transfers between Levels 1 and 2 occur reflecting a change in whether pricing services were used to determine the fair value of equity securities traded principally in foreign markets based upon a determination by management that there had been a significant trend in the U.S. equity markets or in index futures trading after the foreign markets closed or if quoted

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

market prices were used to determine fair values of these equity securities. Transfers into and out of Levels 1 and 2 of the fair value hierarchy are reported at fair values as of the beginning of the period in which the transfers occur.

With the exception of the aircraft that was classified as held for sale as of December 31, 2009 (and further discussed below), Federated did not hold any nonfinancial assets or liabilities measured at fair value on a recurring basis at September 30, 2010 or December 31, 2009.

(b) Fair Value Measurements on a Nonrecurring Basis

Since 2008, Federated has experienced significant declines in the assets under management related to certain quantitative investment products acquired in 2006. The declines in assets under management reflect significant market depreciation as well as investor net redemptions. In light of these declines in assets under management, performance relative to peers and indices and the uncertainty regarding each of these in the future, the carrying values of the related intangible assets have been tested for recoverability at various times over the last 18 months. In the first quarter 2009, as a result of management’s impairment testing, Federated recorded a $15.5 million impairment charge in Intangible asset impairment and amortization on the Consolidated Statements of Income. In the second quarter 2010, management’s quarterly recoverability test of the carrying value of these intangible assets indicated that the carrying values were not fully recoverable. Cash flow projections at June 30, 2010 were lower than previous projections prepared in connection with this recoverability testing as a result of additional declines in assets under management due to market depreciation and net outflows. Management estimated the fair value of these intangible assets based primarily upon expected future cash flows using an income approach valuation methodology with unobservable market data inputs (Level 3). Such inputs included (1) an estimated rate of change for underlying assets under management; (2) expected revenue per managed asset; (3) direct operating expenses; and (4) a discount rate. Management estimates a rate of change for underlying assets under management based on a combination of an estimated rate of market appreciation or depreciation and an estimated net redemption or sales rate. Expected revenue per managed asset and direct operating expenses are generally based on contract terms, average market participant data and historical experience. The discount rate is estimated at the current market rate of return. In addition, because of the subjective nature of the projected discounted cash flows, management considered several scenarios and used probability weighting to calculate the expected future cash flows attributable to the intangible assets. The probability-weighted scenarios assumed growth rates in assets under management ranging from -100% to 9% over the cash-flow projection period. As a result of this fair value analysis, Federated recorded a $7.0 million impairment charge on the Consolidated Statements of Income, $5.6 million of which was included in Intangible asset impairment and amortization with the remainder in Other operating expenses. As a result, the related customer relationship intangible assets were written down to $4.3 million, the noncompete agreement included in Other intangible assets was written down to $1.6 million and the related fixed assets were written down to $1.4 million as of June 30, 2010. Intangible asset amortization expense for the succeeding 5 years will be reduced as a result of this impairment. See Note (9) for the revised successive five-year amortization table. Given the uncertainties regarding future market conditions, the timing and pace of a forecasted recovery and possible prolonged periods of underperformance compared to peers and indices and the significance of these factors to assets under management, management cannot be certain of the outcome of future undiscounted cash flow analyses.

As a result of deterioration in the resale market for used aircraft in 2008 and 2009 and management’s intent to sell its aircraft before the end of its previously estimated useful life, Federated recognized impairment charges totaling $5.2 million to write down the carrying value of one of Federated’s aircraft in 2009. Based upon independent valuation and market data for similar assets (Level 2), management estimated the value of this aircraft less expected costs to sell to be $3.4 million at December 31, 2009. The impairment charges of $3.7 million, $1.0 million and $0.5 million were recorded as operating expense in Other on the Consolidated Statements of Income for the first, third and fourth quarters of 2009, respectively. As a result of adopting a plan to sell this aircraft late in 2009, this aircraft was included in Other current assets on the Consolidated Balance Sheets as of December 31, 2009. In the first quarter 2010, this aircraft was sold for net proceeds of $3.3 million. The loss on sale was recorded as an operating expense in Other on the Consolidated Statements of Income in the first quarter of 2010.

(c) Fair Value Measurements of Other Financial Instruments

The fair value of Federated’s nonrecourse debt is estimated based on estimated annual redemption and market appreciation rates of the underlying B-share fund assets. Based on this estimate, the carrying value of nonrecourse debt appearing on the Consolidated Balance Sheets approximates fair value.

 

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Table of Contents

Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

The fair value of Federated’s recourse debt is estimated based on the current market rate for debt with similar remaining maturities. Based on this fair value estimate, the carrying value of recourse debt appearing on the Consolidated Balance Sheets approximates fair value.

(8) Investments

Investments on the Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009 included available-for-sale and trading securities. At September 30, 2010 and December 31, 2009, Federated held investments totaling $66.0 million and $7.6 million, respectively, in fluctuating-value mutual funds that were classified as available-for-sale securities.

Federated’s trading securities totaled $27.2 million and $23.9 million at September 30, 2010 and December 31, 2009, respectively. Federated consolidates certain sponsored products into its Consolidated Financial Statements as a result of Federated’s controlling financial interest in the products (see Note (6)). As a result, all investments held by these sponsored products were included in Federated’s Consolidated Balance Sheets as of September 30, 2010 and December 31, 2009 as trading securities. Federated’s trading investments primarily represented stocks of large- and mid-cap U.S. and international companies and investment-grade debt securities.

Available-for-sale securities were as follows:

 

     At September 30, 2010      At December 31, 2009  
            Gross Unrealized     Estimated
Market
Value
            Gross Unrealized     Estimated
Market
Value
 

(in thousands)

   Cost      Gains      (Losses)        Cost      Gains      (Losses)    

Equity mutual funds

   $ 47,362       $ 2,048       $ (557   $ 48,853       $ 2,301       $ 343       $ 0      $ 2,644   

Fixed-income mutual funds

     16,411         736         (5     17,142         4,620         332         (5     4,947   
                                                                     

Total fluctuating-value mutual funds

   $ 63,773       $ 2,784       $ (562   $ 65,995       $ 6,921       $ 675       $ (5   $ 7,591   
                                                                     

During the first nine months of 2010, Federated invested $55.0 million of available cash in various sponsored equity and fixed-income mutual funds. As of September 30, 2010, unrealized losses of $0.6 million related primarily to equity investments with a fair value of $14.5 million, all of which were outstanding for less than 160 days.

The following table presents gains and losses recognized in Gain on securities, net on the Consolidated Statements of Income in connection with investments:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands)

   2010     2009     2010     2009  

Unrealized gain (loss) on trading securities

   $ 2,440      $ 1,477      $ (75   $ 2,606   

Realized gains1, 3

     1,104        323        2,329        818   

Realized losses2, 3

     (118     (348     (1,419     (1,334

Impairments

     0        0        0        (386
                                

Gain on securities, net

   $ 3,426      $ 1,452      $ 835      $ 1,704   
                                

 

1

Realized gains of $1,094 and $323 related to the disposal of trading securities for the three months ended September 30, 2010 and 2009, respectively. Realized gains of $10 and $0 related to the disposal of available-for-sale securities for the three months ended September 30, 2010 and 2009, respectively. Realized gains of $2,294 and $786 related to the disposal of trading securities for the nine months ended September 30, 2010 and 2009, respectively. Realized gains of $35 and $32 related to the disposal of available-for-sale securities for the nine months ended September 30, 2010 and 2009, respectively.

2

Realized losses of $118 and $348 related to the disposal of trading securities for the three months ended September 30, 2010 and 2009, respectively. Realized losses of $1,417 and $1,334 related to the disposal of trading securities for the nine months ended September 30, 2010 and 2009, respectively.

3

Realized gains and losses are computed on a specific-identification basis.

 

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Table of Contents

Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

(9) Intangible Assets and Goodwill

Federated’s identifiable intangible assets consisted of the following at September 30:

 

     September 30, 2010      December 31, 2009  

(in thousands)

   Cost      Accumulated
Amortization
    Carrying
Value
     Cost      Accumulated
Amortization
    Carrying
Value
 

Finite-lived intangible assets:

               

Customer relationships1

   $ 130,539       $ (109,781   $ 20,758       $ 134,869       $ (100,710   $ 34,159   

Noncompete agreements2

     12,837         (8,494     4,343         14,396         (6,932     7,464   
                                                   

Total finite-lived intangible assets3

     143,376         (118,275     25,101         149,265         (107,642     41,623   
                                                   

Indefinite-lived intangible assets:

               

Renewable investment advisory rights

     64,500         N/A        64,500         37,800         N/A        37,800   

Trade names

     1,900         N/A        1,900         1,900         N/A        1,900   
                                                   

Total indefinite-lived intangible assets

     66,400         N/A        66,400         39,700         N/A        39,700   
                                                   

Total identifiable intangible assets

   $ 209,776       $ (118,275   $ 91,501       $ 188,965       $ (107,642   $ 81,323   
                                                   

 

1

Weighted average amortization period of 9.6 years as of September 30, 2010

2

Weighted average amortization period of 7.0 years as of September 30, 2010

3

Weighted average amortization period of 9.4 years as of September 30, 2010

The decrease of $5.9 million in the cost of the Total finite-lived intangible assets at September 30, 2010 as compared to December 31, 2009 primarily relates to a $5.6 million impairment charge recorded in the second quarter of 2010. See Note (7)(b) for additional information on the impairment.

The increase of $26.7 million in the cost of the Renewable investment advisory rights indefinite-lived intangible assets at September 30, 2010, as compared to December 31, 2009, reflects the purchase price related to the SunTrust Acquisition. See Note (4) for additional information.

Amortization expense for identifiable intangible assets for the three- and nine-month periods ended September 30, 2010 was $3.4 million and $10.9 million, respectively, and $4.0 million and $12.6 million, respectively, for the same periods of 2009. This expense was included in Intangible asset impairment and amortization on the Consolidated Statements of Income for each period.

Following is a schedule of expected aggregate annual amortization expense for intangible assets in each of the five succeeding years assuming no new acquisitions or impairments:

 

(in millions)

   For the years ending
December 31,
 

2010

   $ 14.3   

2011

   $ 7.5   

2012

   $ 3.9   

2013

   $ 3.1   

2014

   $ 2.4   

Goodwill at September 30, 2010 and December 31, 2009 was $609.8 million and $581.7 million, respectively. During the first nine months of 2010, Federated recorded goodwill primarily in connection with contingent purchase price payments and accruals related to the 2005 acquisition of the cash management business of Alliance Capital Management L.P. (Alliance Acquisition) ($6.8 million) and the 2008 acquisition of certain assets of David W. Tice & Associates LLC that relate to the management of the Prudent Bear Fund and the Prudent DollarBear Fund (Prudent Bear Acquisition) ($19.4 million). See Note (16)(a) for additional information.

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

(10) Purchased Loans

During the second quarter 2010, Federated began investing in syndicated, commercial, US dollar-denominated, floating-rate term loans. During the third quarter 2010, Federated transferred $43.4 million in purchased loans and $2.7 million in cash into a new Federated sponsored fund in exchange for shares of the fund. This transfer of assets was recorded as a sale for accounting purposes given that the loans were legally isolated from Federated, the Federated sponsored fund has the right to pledge or exchange the loans and Federated has not maintained effective control over the transferred loans. Federated recorded $0.6 million in Gain on securities, net on the Consolidated Statements of Income as a result of the sale of these loans. As of September 30, 2010, the fair value of the remaining purchased loans, which totaled $3.9 million, was included in Other current assets on the Consolidated Balance Sheets. Of this amount, purchases of $2.8 million had not settled as of September 30, 2010; therefore, an offsetting amount was recorded in Other current liabilities on the Consolidated Balance Sheets. The aggregate unpaid principal balance on the purchased loans approximated fair value as of September 30, 2010. As of September 30, 2010, there were no defaults on any of the remaining purchased loans.

(11) Other Current Liabilities

Federated’s Other current liabilities at September 30, 2010 included an accrual of $19.4 million related to the second anniversary contingent purchase price payment for the Prudent Bear Acquisition, which is payable no later than March 2011 (see Note (16)(a) for additional information), $18.4 million related to the interest rate swap (see Note (12) for additional information) and $2.8 million related to unsettled purchased loans (see Note (10) for additional information).

Federated’s Other current liabilities at December 31, 2009 included an accrual of $28.9 million related to the contingent purchase price payments for the 2005 acquisition of the cash management business of Alliance Capital Management L.P. (Alliance Acquisition) which was paid in April 2010. The final payment for the Alliance Acquisition of $3.3 million was paid in July 2010. Also included in Other current liabilities at December 31, 2009 was $20.8 million related to insurance proceeds for claims submitted to cover costs associated with the government investigations into past mutual fund trading practices and related legal proceedings (see Note (16)(c)). The retention of these advance insurance payments was contingent upon final approval of the claim by the insurance carrier. In the event that all or a portion of the claim was denied, Federated would have been required to repay all or a portion of these advance payments. During the second quarter 2010, Federated received an additional $4.2 million in related insurance proceeds and received final approvals by the insurance carrier for $25 million of claims. Accordingly, $25 million of proceeds were recognized on the Consolidated Statements of Income for the second quarter 2010 as reductions to the operating expense line items originally charged.

(12) Recourse Debt and Interest Rate Swap

Recourse debt consisted of the following:

 

(dollars in thousands)

   Weighted-
Average
Interest Rates
    Maturity Date      September 30,
2010
     December 31,
2009
 
   20101     20092          

Term Loan

     4.396     1.72     April 1, 2015       $ 414,375       $ 126,000   

Less: Short-term debt – recourse

            42,500         21,000   
                        

Long-term debt – recourse

          $ 371,875       $ 105,000   
                        

 

1

As of September 30, 2010; See additional information below regarding the interest rate fixed at 4.396% in connection with the interest rate swap.

2

As of December 31, 2009

During the second quarter 2010, Federated entered into a five-year $425 million amended and restated term loan credit agreement by and among Federated, certain of its subsidiaries and a syndicate of 22 banks led by PNC Capital Markets LLC as sole bookrunner and joint lead arranger and Citigroup Global Markets, Inc. as joint lead arranger (Term Loan).

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

The Term Loan amended and restated Federated’s $140 million term loan dated August 19, 2008. The Term Loan requires principal payments of $10.6 million per quarter for the first four years and $63.8 million per quarter for the fifth year with the final payment due on April 1, 2015. Certain subsidiaries entered into an Amended and Restated Continuing Agreement of Guaranty and Suretyship whereby these subsidiaries guarantee payment of all obligations incurred through the Term Loan. The Term Loan also includes representations, warranties and other financial and non-financial covenants. Proceeds from the Term Loan were used to refinance and repay the existing debt and are being used for general corporate purposes. The Term Loan qualified for modification accounting treatment. Accordingly, closing costs of $2.8 million were capitalized in the second quarter 2010 and are being amortized over the 5-year term of the loan.

During the first quarter 2010, Federated entered into an interest rate swap to hedge its interest rate risk associated with the $425 million Term Loan (the Swap). The Swap, which became effective in the second quarter 2010, had an initial notional amount of $425 million that declines in accordance with the scheduled principal payments associated with the Term Loan. Under the Swap, which expires on April 1, 2015, Federated receives payments based on the London Interbank Offering Rate (LIBOR) plus a spread and makes payments based on an annual fixed rate of 4.396%. The Swap requires monthly cash settlements of interest paid or received. The differential between the interest paid or interest received from the monthly settlements will be recorded as adjustments to Debt expense – recourse on the Consolidated Statements of Income. The Swap is accounted for as a cash flow hedge and has been determined to be highly effective. Federated evaluates effectiveness using the long-haul method. Changes in the fair value of the Swap will likely be offset by an equal and opposite change in the fair value of the hedged item, therefore very little, if any, net impact on reported earnings is expected. The fair value of the Swap agreement at September 30, 2010 was a liability of $18.4 million which was recorded in Other current liabilities on the Consolidated Balance Sheets. The entire amount of this loss in fair value was recorded in Accumulated other comprehensive (loss) income, net of tax on the Consolidated Balance Sheets at September 30, 2010. During the next twelve months management expects to charge $8.2 million of this after-tax loss to Debt expense – recourse on the Consolidated Statements of Income as a component of Federated’s fixed interest rate of 4.396%. This amount could differ from amounts actually recognized due to changes in interest rates subsequent to September 30, 2010 and will not affect the amount of interest expense recognized in total on the Term Loan for any period presented. During the three- and nine-month periods ended September 30, 2010, $2.2 million and $4.3 million, respectively, were charged to Debt expense – recourse on the Consolidated Statements of Income as a component of Federated’s fixed interest rate of 4.396%.

In addition, as of September 30, 2010 and December 31, 2009, all of Federated’s $200 million Revolving Credit Facility was available for borrowings.

(13) Share-Based Compensation Plans

(a) Restricted Stock

During the first nine months of 2010, Federated awarded 352,879 shares of restricted Federated Class B common stock in connection with a bonus program in which certain key employees received a portion of their bonus in the form of restricted stock under Federated’s Stock Incentive Plan. This restricted stock, which was granted on the bonus payment date and issued out of treasury, will generally vest over a three-year period. Federated awarded 1,155,136 shares of restricted Federated Class B common stock under its Stock Incentive Plan to employees during 2009.

(b) Stock Options

During the first nine months of 2010, 51,900 employee stock options were exercised and the resulting shares were issued out of treasury. Options exercised during 2009 totaled 345,275.

(c) Non-management Director Award

During the first nine months of 2010, Federated awarded 6,000 shares of Federated Class B common stock to non-management directors. During 2009, Federated awarded 12,000 fully vested stock options to non-management directors.

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

 

(14) Equity

During 2008, the board of directors authorized a share repurchase program with no stated expiration date that allows Federated to buy back as many as 5 million shares of Class B common stock. No other programs existed as of September 30, 2010. The program authorizes executive management to determine the timing and the amount of shares for each purchase. The repurchased stock will be held in treasury for employee share-based compensation plans, potential acquisitions and other corporate activities.

During the first nine months of 2010, Federated repurchased 0.4 million shares of common stock for $9.3 million, the majority of which were repurchased in the open market and the remainder of which were repurchased in connection with employee separations and were not counted against the board-approved share repurchase program. At September 30, 2010, 3.8 million shares remain available to be purchased under the current buyback program.

(15) Earnings Per Share Attributable to Federated Investors, Inc. Shareholders

The following table sets forth the computation of basic and diluted earnings per share using the two-class method for amounts attributable to Federated Investors, Inc.:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in thousands, except per share data)

   2010     2009     2010     2009  

Numerator – Basic

        

Net income attributable to Federated Investors, Inc.

   $ 43,056      $ 56,986      $ 132,713      $ 145,394   

Less: Total income available to participating unvested restricted shareholders1

     (1,251     (1,436     (5,766     (3,514
                                

Total net income attributable to Federated Common Stock2

   $ 41,805      $ 55,550      $ 126,947      $ 141,880   
                                

Numerator – Diluted

        

Net income attributable to Federated Investors, Inc.

   $ 43,056      $ 56,986      $ 132,713      $ 145,394   

Less: Total income available to participating unvested restricted shareholders1

     (1,251     (1,435     (5,766     (3,512
                                

Total net income attributable to Federated Common Stock2

   $ 41,805      $ 55,551      $ 126,947      $ 141,882   
                                

Denominator

        

Basic weighted-average common shares outstanding

     99,916        99,958        99,907        99,976   

Dilutive potential shares from stock options

     38        128        84        120   
                                

Diluted weighted-average common shares outstanding

     99,954        100,086        99,991        100,096   
                                

Earnings per Share

        

Net income attributable to Federated Common Stock – Basic2

   $ 0.42      $ 0.56      $ 1.27      $ 1.42   
                                

Net income attributable to Federated Common Stock – Diluted2

   $ 0.42      $ 0.56      $ 1.27      $ 1.42   
                                

 

1

Income available to participating restricted shareholders includes dividends paid to unvested restricted shareholders, net of estimated and actual forfeited dividends, and their proportionate share of undistributed earnings, if any.

2

Federated Common Stock excludes unvested restricted stock which are deemed participating securities in accordance with the two-class method of computing earnings per share.

For the three- and nine-month periods ended September 30, 2010, 3.4 million and 2.9 million stock option awards, respectively, were outstanding, but not included in the computation of diluted earnings per share for each period because the exercise price was greater than the average market price of Federated Class B common stock for each respective period. For the three- and nine-month periods ended September 30, 2009, 1.9 million and 2.9 million stock option awards, respectively, were outstanding, but not included in the computation of diluted earnings per share for each period because the exercise price was greater than the average market price of Federated Class B common stock for each respective period. In the event the awards

 

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Table of Contents

Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

become dilutive, these shares would be included in the calculation of diluted earnings per share and would result in additional dilution.

(16) Commitments and Contingencies

(a) Contractual

As part of the SunTrust Acquisition, Federated is required to make contingent purchase price payments over the five-year period following the acquisition date. The contingent purchase price payments will be calculated as a percentage of revenue less operating expenses directly attributed to certain eligible assets. Based on asset levels of $14.5 billion, the additional payments would total approximately $27 million over five years. The actual amount of the contingent payments will vary based on asset levels and related net revenues. Management is unable to reasonably estimate a range of possible outcomes due to the wide range of possible flow-rate scenarios for the assets under management. As of September 30, 2010, a liability of $21.8 million representing the fair value of future consideration payments was recorded in Other long-term liabilities (see Note (7)(a) for a discussion regarding the valuation methodology). This liability will be remeasured at each reporting date and changes in the fair value will be recognized in earnings.

As part of the Prudent Bear Acquisition, Federated is required to make contingent purchase price payments based upon certain revenue growth targets over the four-year period following the acquisition date. The contingent purchase price payments, which could total as much as $99.5 million, will be recorded as additional goodwill at the time the contingency is resolved. The first contingent purchase price payment of $5.1 million was paid in the first quarter of 2010. As of September 30, 2010, $19.4 million was accrued for the second anniversary year payment expected to be made as early as Q4 2010 but no later than March 2011.

In the fourth quarter 2008, Federated acquired certain assets of Clover Capital Management, Inc. (Clover Capital Acquisition). As part of the Clover Capital Acquisition, Federated is required to make contingent purchase price payments based upon growth in revenues over the five-year period following the acquisition date. The contingent purchase price payments, which could total as much as $56 million, will be recorded as additional goodwill at the time the contingency is resolved. The applicable growth targets were not met for the first payment related to the anniversary year ended in December 2009. As such, no amounts were accrued in 2009 or paid in 2010. No amounts were accrued as of September 30, 2010 for the second anniversary year ending in December 2010.

As part of the Alliance Acquisition, Federated was required to make contingent purchase price payments over a five-year period following the acquisition date. These payments were primarily calculated as a percentage of revenues less certain operating expenses directly attributed to the assets acquired. Contingent purchase price payments of $10.7 million, $13.3 million, $16.2 million, $19.8 million and $32.4 million were paid in the second quarters of 2006, 2007, 2008, 2009, and 2010, respectively. In addition, a final contingent purchase payment of $3.3 million was paid in the third quarter 2010. Contingent payments were recorded as additional goodwill at the time the related contingency was resolved.

In the third quarter 2007, Federated completed a transaction with Rochdale Investment Management LLC to acquire certain assets relating to its business of providing investment advisory and investment management services to the Rochdale Atlas Portfolio (Rochdale Acquisition). The Rochdale Acquisition agreement provides for two forms of contingent purchase price payments that are dependent upon asset growth and fund performance through 2012. The first form of contingent payment is payable in 2010 and 2012 and could aggregate to as much as $20 million. The second form of contingent payment is payable on a semi-annual basis over the five-year period following the acquisition closing date based on certain revenue earned by Federated from the Federated InterContinental Fund. As of September 30, 2010, $2.5 million was paid in semi-annual contingent purchase price payments, $0.6 million was accrued related to future semi-annual contingent purchase price payments and $1.1 million was accrued with regard to the first form of contingent payment payable in the fourth quarter 2010. Both of these future payments were accrued in Other current liabilities and recorded as goodwill. Contingent payments are recorded as additional goodwill at the time the related contingency is resolved.

Pursuant to various significant employment arrangements, Federated may be required to make certain incentive compensation-related payments. The employment contracts expire on various dates through the year 2014 with payments possible through 2018. As of September 30, 2010, the maximum bonus payable over the remaining terms of the contracts approximates $91 million, none of which would be payable in the remainder of 2010. In addition, certain employees have incentive compensation opportunities related to the Federated Kaufmann Large Cap Fund (the Fund Bonus). Based on current asset levels, $0.1 million

 

20


Table of Contents

Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

would be paid in 2011 as the first Fund Bonus payment. Management is unable to reasonably estimate a range of possible bonus payments for the Fund Bonus for subsequent years due to the wide range of possible growth-rate scenarios.

Pursuant to other long-term employment arrangements, Federated may be required to make additional payments upon the occurrence of certain events. Under these other agreements, payments could occur on an annual basis and continue through 2013.

(b) Guarantees and Indemnifications

On an intercompany basis, various wholly owned subsidiaries of Federated guarantee certain financial obligations of Federated Investors, Inc., and Federated Investors, Inc. guarantees certain financial and performance-related obligations of various wholly owned subsidiaries. In addition, in the normal course of business, Federated has entered into contracts that provide a variety of indemnifications. Typically, obligations to indemnify third parties arise in the context of contracts entered into by Federated, under which Federated agrees to hold the other party harmless against losses arising out of the contract, provided the other party’s actions are not deemed to have breached an agreed upon standard of care. In each of these circumstances, payment by Federated is contingent on the other party making a claim for indemnity, subject to Federated’s right to challenge the other party’s claim. Further, Federated’s obligations under these agreements may be limited in terms of time and/or amount. It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of Federated’s obligations and the unique facts and circumstances involved in each particular agreement. Management believes that if Federated were to incur a loss in any of these matters, such loss should not have a material effect on its business, financial position or results of operations.

(c) Past Mutual Fund Trading Issues and Related Legal Proceedings

During the fourth quarter 2005, Federated entered into settlement agreements with the SEC and New York State Attorney General to resolve the past mutual fund trading issues. Under the terms of the settlements, Federated paid for the benefit of fund shareholders a total of $80.0 million. In addition, Federated agreed to reduce the investment advisory fees on certain Federated Funds by $4.0 million per year for the five-year period beginning January 1, 2006, based upon effective fee rates and assets under management as of September 30, 2005. Depending upon the level of assets under management in these funds during the five-year period, the actual investment advisory fee reduction could be greater or less than $4.0 million per year. For each of the nine months ended September 30, 2010 and 2009, these fee reductions were approximately $2 million.

Since October 2003, Federated has been named as a defendant in twenty-three cases filed in various federal district courts and state courts involving allegations relating to market timing, late trading and excessive fees. One market timing/late trading case was voluntarily dismissed by the plaintiff without prejudice. All of the pending cases involving allegations related to market timing and late trading have been transferred to the U.S. District Court for the District of Maryland and consolidated for pre-trial proceedings. Without admitting the validity of any claim, Federated reached a settlement with the plaintiffs in these pending cases. The settlement was accrued in a prior period and the accrual was not material to the Consolidated Financial Statements. A hearing to address final approval of the settlement was held on October 21 and October 22, 2010. The Court entered an order granting final approval of the settlement on October 25, 2010.

The seven excessive fee cases were originally filed in five different federal courts and one state court. All six of the federal cases are now consolidated and pending in the U.S. District Court for the Western District of Pennsylvania. The state court case was voluntarily dismissed by the plaintiff without prejudice.

The plaintiffs in the excessive fee cases seek compensatory damages reflecting a return of all advisory fees earned by Federated in connection with the management of the Federated Kaufmann Fund since June 28, 2003, as well as attorneys’ fees and expenses. The remaining lawsuits seek unquantified damages, attorneys’ fees and expenses. Federated is defending this litigation. The potential impact of these lawsuits and similar suits against third parties, as well as the timing of settlements, judgments or other resolution of these matters, is uncertain. It is possible that an unfavorable determination will cause a material adverse impact on Federated’s financial position, results of operations and/or liquidity in the period in which the effect becomes reasonably estimable.

The Consolidated Financial Statements for the nine-month periods ended September 30, 2010 and 2009 reflect $7.9 million and $8.9 million, respectively, for costs associated with various legal, regulatory and compliance matters, including costs incurred on behalf of the funds, costs incurred and estimated to complete the distribution of Federated’s regulatory settlement,

 

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Notes to the Consolidated Financial Statements (continued)

 

(Unaudited)

 

costs related to certain other undertakings of these settlement agreements, and costs incurred and estimated to resolve certain of the above-mentioned ongoing legal proceedings. Accruals for these estimates represent management’s best estimate of probable losses at this time. Actual losses may differ from these estimates, and such differences may have a material impact on Federated’s consolidated results of operations, financial position or cash flows.

(d) Other Legal Proceedings

Federated has other claims asserted and threatened against it in the ordinary course of business. As of September 30, 2010, Federated does not believe that a material loss related to these claims is reasonably estimable. These claims are subject to inherent uncertainties. It is possible that an unfavorable determination will cause a material adverse impact on Federated’s reputation, financial position, results of operations and/or liquidity in the period in which the effect becomes reasonably estimable.

(17) Subsequent Events

On October 28, 2010, the board of directors declared a $0.24 per share dividend to shareholders of record as of November 8, 2010 to be paid on November 15, 2010.

 

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Part I, Item 2. Management’s Discussion and Analysis

 

of Financial Condition and Results of Operations (Unaudited)

The discussion and analysis below should be read in conjunction with the consolidated financial statements appearing elsewhere in this report. Management has presumed that the readers of this interim financial information have read or have access to Management’s Discussion and Analysis of Financial Condition and Results of Operations appearing in Federated’s Annual Report on Form 10-K for the year ended December 31, 2009.

General

Federated Investors, Inc. (together with its subsidiaries, Federated) is one of the largest investment managers in the United States with $341 billion in managed assets as of September 30, 2010. The majority of Federated’s revenue is derived from advising and administering Federated mutual funds and Separate Accounts (which include separately managed accounts, institutional accounts, sub-advised funds and other managed products) in both domestic and international markets. Federated also derives revenue from providing various other mutual fund-related services, including distribution, shareholder servicing and retirement plan recordkeeping services (collectively, Other Services).

Federated’s investment products are primarily distributed in three markets. These markets and the relative percentage of managed assets at September 30, 2010 attributable to such markets are as follows: wealth management and trust (49%), broker/dealer (30%) and global institutional (18%).

Investment advisory fees, administrative service fees and certain fees for Other Services, such as distribution and shareholder service fees, are contract-based fees that are generally calculated as a percentage of the net assets of the investment portfolios that are managed by Federated. As such, Federated’s revenue is primarily dependent upon factors that affect the value of managed assets including market conditions and the ability to attract and retain assets. Nearly all assets under management in Federated’s investment products can be redeemed at any time with no advance notice requirement. Fee rates for Federated’s services generally vary by asset type and investment objective and, in certain instances, decline as the average net assets of the individual portfolios exceed certain thresholds. Generally, rates charged for advisory services provided to equity products are higher than rates charged on money market and fixed-income products and liquidation portfolios. Likewise, mutual funds typically have a higher fee rate than Separate Accounts. Similarly, traditional separate accounts typically have a higher fee rate than liquidation portfolios. Accordingly, revenue is also dependent upon the relative composition of average assets under management across both asset and product types. Federated may waive certain fees for competitive reasons such as to maintain positive or zero net yields, to meet regulatory requirements (including settlement-related waivers (see Note (16)(c) to the Consolidated Financial Statements)) or to meet contractual requirements. Since Federated’s products are largely distributed and serviced through financial intermediaries, Federated pays a portion of its fees earned from sponsored products to the financial intermediaries that sell these products. These payments are generally calculated as a percentage of net assets attributable to the party receiving the payment and are recorded on the Consolidated Statements of Income as a distribution expense.

Federated’s remaining Other Services fees are primarily based on fixed rates per retirement plan participant. Revenue relating to these services generally depends upon the number of plan participants, which may vary as a result of sales and marketing efforts, competitive fund performance, introduction and market reception of new product features and acquisitions.

Federated’s most significant operating expenses include distribution expenses and compensation and related costs, which represent fixed and variable compensation and related employee benefits. Certain of these expenses are dependent upon sales, product performance, levels of assets, asset mix and management’s willingness to continue fee waivers to maintain positive or zero net yields.

The discussion and analysis of Federated’s financial condition and results of operations are based on Federated’s Consolidated Financial Statements. Management evaluates Federated’s performance at the consolidated level based on the view that Federated operates in a single operating segment, the investment management business. Management analyzes all expected revenue and expenses and considers market demands in determining an overall fee structure for services provided and in evaluating the addition of new business. Federated’s growth and profitability are dependent upon its ability to attract and retain assets under management and, in light of the recent and continuing adverse market conditions, are also dependent upon the profitability of those assets, which is impacted, in part, by management’s decisions regarding fee waivers to maintain positive or zero net yields on certain products. Fees for fund-related services are ultimately subject to the approval of the independent directors or trustees of the mutual funds. Management believes the most meaningful indicators of Federated’s performance are assets under management, total revenue and net income, both in total and per diluted share.

 

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Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

 

Business Developments

Continuing Disruption in Global Financial Markets

In recent years, the financial markets have experienced periods of extreme volatility due to uncertainty and disruption in large segments of the credit markets. During the latter half of 2008 and early 2009, the disruptions in the financial markets worsened causing severe dislocations on the functioning of the markets and unprecedented strain on the availability of liquidity in the short-term debt markets, including the commercial paper markets, which are important for the operation of prime money market funds which invest primarily in a portfolio of short-term, high-quality, fixed-income securities.

Through the adverse market conditions of 2008, Federated’s government agency and treasury money market funds experienced significant asset inflows, which drove substantial increases in Federated’s money market managed assets. These funds grew as certain investors favored the perceived safety and liquidity of portfolios backed by government securities over other investment products. In certain products, the gross yield is not sufficient to cover all of the fund’s normal operating expenses. During the fourth quarter 2008, Federated began waiving fees in order for certain funds to maintain positive or zero net yields.

During the nine months ended September 30, 2010, fee waivers to maintain positive or zero net yields totaled $181.6 million and were partially offset by a related reduction in distribution expenses of $139.8 million such that the net impact to Federated was $41.8 million in reduced operating income. The impact of these fee waivers for the nine months ended September 30, 2010 was significantly more than the impact for the nine months ended September 30, 2009 with $63.1 million in waived fees, $43.8 million in reduced distribution expenses and a net impact on operating income of $19.3 million. Conversely, the net impact of these fee waivers on operating income for the quarter ended September 30, 2010 ($11.0 million) was less than in the fourth quarter 2009 ($14.9 million), the first quarter 2010 ($17.8 million) and the second quarter 2010 ($13.0 million). Management expects the fee waivers and the related reduction in distribution expense will continue for the remainder of 2010 and into 2011 and will likely be material. Assuming current market conditions and asset levels remain constant, fee waivers for the fourth quarter 2010 may result in a net impact on operating income of approximately $11 million to $12 million. Increases in short-term interest rates that result in higher yields on securities purchased in money market fund portfolios would reduce the operating income impact of these waivers. Management is unable to predict the amount of future fee waivers as they are contingent on a number of variables including, but not limited to, available yields on instruments held by the funds, changes in assets within the funds, actions by the Federal Reserve and the U.S. Department of the Treasury, changes in expenses of the funds, changes in the mix of customer assets, and Federated’s willingness to continue the fee waivers.

For the nine months ended September 30, 2010, approximately 50% of Federated’s total revenue was attributable to money market managed assets as compared to 67% for the same period of 2009. A significant change in Federated’s money market business or a significant reduction in money market managed assets due to regulatory changes, changes in the financial markets including significant increases in interest rates over a short period of time, significant deterioration in investor confidence, further persistent declines in or additional prolonged periods of historically low short-term interest rates and resulting fee waivers or other circumstances, could have a material adverse effect on Federated’s results of operations.

Business Combinations and Acquisitions

In the third quarter 2010, Federated acquired the money market management business of SunTrust Banks, Inc. (SunTrust Acquisition). Pursuant to the definitive agreement signed on July 16, 2010, $11.0 billion of money market assets transitioned to Federated as of September 30, 2010. To date, money market mutual fund assets in nine money market mutual funds managed by SunTrust’s RidgeWorth Capital Management were transitioned into eight existing Federated money market mutual funds with similar investment objectives in connection with the first in a series of closings. Federated expects two more closings to occur in November 2010 to complete the transition.

The transaction includes upfront cash payments that are expected to total up to $7 million, with $4.9 million paid as of September 30, 2010. The transaction also includes contingent purchase price payments payable over five years. The contingent purchase price payments will be calculated as a percentage of revenue less operating expenses directly attributed to certain eligible assets. The contingent payments are not limited by any maximum amount. Based on asset levels of $14.5 billion, the additional contingent payments would total approximately $27 million over five years. The actual amount of the contingent payments will vary based on asset levels and related net revenues. Management is unable to reasonably estimate a range of possible outcomes due to the wide range of possible flow-rate scenarios for the assets under management. As of September 30, 2010, a liability of $21.8 million representing the fair value of future consideration payments was recorded in Other long-term

 

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Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

liabilities (see Note (7)(a) for a discussion regarding the valuation methodology). This liability will be remeasured at each reporting date and changes in the fair value will be recognized in earnings.

The transaction was accounted for under the acquisition method of accounting. Accordingly, the purchase price was allocated to the intangible assets acquired based upon preliminary estimates of fair values as of the acquisition date. Federated is currently completing its valuation to determine the fair value of the identifiable intangible assets and consideration associated with the SunTrust Acquisition. Although the preliminary results of the valuation are reflected in the Consolidated Financial Statements as of September 30, 2010 and for the three- and nine-month periods ended September 30, 2010 and the related footnotes, the final valuation results may require adjustments to this preliminary valuation and such adjustments may be material. See Note (4) and Note (16)(a) to the Consolidated Financial Statements for additional information on this acquisition and the related contingent payments.

Recognition of Insurance Proceeds

In the second quarter 2010, Federated obtained the final approval by the insurance carrier for $25 million of claims submitted over the past several years to cover costs associated with the government investigations into past mutual fund trading practices and related legal proceedings. Accordingly, Federated recognized the $25 million of insurance proceeds on the Consolidated Statements of Income as reductions to the operating expense line items originally charged, including Professional service fees ($21.6 million); Compensation and related ($1.5 million); Office and occupancy ($1.4 million); and Advertising and promotional ($0.5 million).

Special Cash Dividend

A $1.26 per share or $129.8 million special cash dividend was paid in the first quarter 2010. This payment was in addition to the regular quarterly cash dividend of $0.24 per share or $24.7 million also paid in the first quarter 2010. All dividends were considered ordinary dividends for tax purposes. The first quarter 2010 dividend of $1.50 per share negatively impacted first quarter 2010 diluted earnings per share by approximately $0.04 per share due to the application of the two-class method of calculating earnings per share.

Amended and Restated Term Loan and Interest Rate Swap

In the second quarter 2010, Federated entered into a five-year $425 million amended and restated term loan credit agreement by and among Federated, certain of its subsidiaries and a syndicate of 22 banks led by PNC Capital Markets LLC as sole bookrunner and joint lead arranger and Citigroup Global Markets, Inc. as joint lead arranger (Term Loan).

The Term Loan amended and restated Federated’s $140 million term loan dated August 19, 2008. The Term Loan requires principal payments of $10.6 million per quarter for the first four years and $63.8 million per quarter for the fifth year with the final payment due on April 1, 2015. Certain subsidiaries entered into an Amended and Restated Continuing Agreement of Guaranty and Suretyship whereby these subsidiaries guarantee payment of all obligations incurred through the Term Loan. The Term Loan also includes representations, warranties and other financial and non-financial covenants. Proceeds from the Term Loan were used to refinance and repay the existing debt and are being used for general corporate purposes.

The borrowings under the Term Loan bear interest at a spread over the London Interbank Offering Rate (LIBOR). During the first quarter 2010, Federated entered into an interest rate swap transaction (the Swap) which became effective in the second quarter 2010, to hedge its interest rate risk associated with the Term Loan. The Swap had an initial notional amount of $425 million that declines in accordance with the scheduled principal payments associated with the Term Loan. Under the Swap, which expires on April 1, 2015, Federated receives payments based on LIBOR plus a spread and makes payments based on an annual fixed rate of 4.396%. The Term Loan qualifies for modification accounting treatment. Accordingly, closing costs of $2.8 million were capitalized in the second quarter 2010 and are being amortized over the 5-year term of the loan.

Asset Impairments

Since 2008, Federated has experienced significant declines in the assets under management related to certain quantitative investment products acquired in 2006. The declines in assets under management reflect significant market depreciation as well as investor net redemptions. In light of these declines in assets under management, performance relative to peers and indices and the uncertainty regarding each of these in the future, the carrying values of the related intangible assets have been tested for recoverability at various times over the last 18 months. In the first quarter 2009, as a result of management’s impairment testing, Federated recorded a $15.5 million impairment charge in Intangible asset impairment and amortization on the Consolidated Statements of Income. As of June 30, 2010, management’s quarterly recoverability test of the carrying value of

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

these intangible assets indicated that the carrying values were not fully recoverable. Cash flow projections at June 30, 2010 were lower than previous projections prepared in connection with this recoverability testing as a result of additional declines in assets under management due to market depreciation and net outflows. Management estimated the fair value of these intangible assets based primarily upon expected future cash flows using an income approach valuation methodology with unobservable market data inputs (Level 3). See Note (7) to the Consolidated Financial Statements for additional information. Such inputs included (1) an estimated rate of change for underlying assets under management; (2) expected revenue per managed asset; (3) direct operating expenses; and (4) a discount rate. Management estimates a rate of change for underlying assets under management based on a combination of an estimated rate of market appreciation or depreciation and an estimated net redemption or sales rate. Expected revenue per managed asset and direct operating expenses are generally based on contract terms, average market participant data and historical experience. The discount rate is estimated at the current market rate of return. In addition, because of the subjective nature of the projected discounted cash flows, management considered several scenarios and used probability weighting to calculate the expected future cash flows attributable to the intangible assets. The probability-weighted scenarios assumed growth rates in assets under management ranging from -100% to 9% over the cash-flow projection period. In the second quarter 2010, as a result of management’s impairment testing, Federated recorded a $7.0 million impairment charge on the Consolidated Statements of Income, $5.6 million of which was included in Intangible asset impairment and amortization with the remainder in Other operating expenses. As a result, the related customer relationship intangible assets were written down to $4.3 million, the noncompete agreement included in Other intangible assets was written down to $1.6 million and the related fixed assets were written down to $1.4 million as of June 30, 2010. Intangible asset amortization expense for the succeeding 5 years will be reduced as a result of this impairment. See Note (9) for the revised successive five-year amortization table. Given the uncertainties regarding future market conditions, the timing and pace of a forecasted recovery and possible prolonged periods of underperformance compared to peers and indices and the significance of these factors to assets under management, management cannot be certain of the outcome of future undiscounted cash flow analyses.

As a result of deterioration in the resale market for used aircraft in 2008 and 2009 and management’s intent to sell its aircraft before the end of its previously estimated useful life, Federated recognized impairment charges totaling $5.2 million to write down the carrying value of one of Federated’s aircraft in 2009. Based upon independent valuation and market data for similar assets, management estimated the value of this aircraft less expected costs to sell to be $3.4 million at December 31, 2009. The impairment charges of $3.7 million, $1.0 million and $0.5 million were recorded as operating expense in Other on the Consolidated Statements of Income for the first, third and fourth quarters of 2009, respectively. As a result of adopting a plan to sell this aircraft late in 2009, this aircraft was included in Other current assets on the Consolidated Balance Sheets as of December 31, 2009. In the first quarter 2010, this aircraft was sold for net proceeds of $3.3 million. The loss on sale was recorded as an operating expense in Other on the Consolidated Statements of Income in the first quarter 2010.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

 

Asset Highlights

Managed Assets at Period End

 

      September 30,      Percent
Change
 

(in millions)

   2010      2009     

By Asset Class

        

Money market

   $ 260,899       $ 318,064         (18 %) 

Fixed-income

     40,174         32,039         25

Equity

     29,133         29,124         0

Liquidation portfolios1

     11,071         13,073         (15 %) 
                          

Total managed assets

   $ 341,277       $ 392,300         (13 %) 
                          
By Product Type         

Funds:

        

Money market

   $ 233,611       $ 287,634         (19 %) 

Fixed-income

     32,211         26,960         19

Equity

     21,325         20,350         5
                          

Total mutual fund assets

   $ 287,147       $ 334,944         (14 %) 
                          

Separate Accounts:

        

Money market

   $ 27,288       $ 30,430         (10 %) 

Fixed-income

     7,963         5,079         57

Equity

     7,808         8,774         (11 %) 
                          

Total separate account assets

   $ 43,059       $ 44,283         (3 %) 
                          

Liquidation Portfolios1

   $ 11,071       $ 13,073         (15 %) 
                          

Total managed assets

   $ 341,277       $ 392,300         (13 %) 
                          

Average Managed Assets

 

      Three Months Ended
September 30,
     Percent
Change
    Nine Months Ended
September 30,
     Percent
Change
 

(in millions)

   2010      2009        2010      2009     
By Asset Class                 

Money market

   $ 260,098       $ 336,530         (23 %)    $ 270,276       $ 353,434         (24 %) 

Fixed-income

     39,192         30,376         29     36,691         27,190         35

Equity

     28,033         27,872         1     28,769         25,793         12

Liquidation portfolios1

     11,313         13,370         (15 %)      11,797         4,994         136
                                                    

Total average managed assets

   $ 338,636       $ 408,148         (17 %)    $ 347,533       $ 411,411         (16 %) 
                                                    
By Product Type                 

Funds:

                

Money market

   $ 232,230       $ 304,959         (24 %)    $ 239,523       $ 320,511         (25 %) 

Fixed-income

     31,491         25,499         23     30,362         22,684         34

Equity

     20,411         19,215         6     20,657         17,558         18
                                                    

Total average mutual fund assets

   $ 284,132       $ 349,673         (19 %)    $ 290,542       $ 360,753         (19 %) 
                                                    

Separate Accounts:

                

Money market

   $ 27,868       $ 31,571         (12 %)    $ 30,753       $ 32,923         (7 %) 

Fixed-income

     7,701         4,877         58     6,329         4,506         40

Equity

     7,622         8,657         (12 %)      8,112         8,235         (1 %) 
                                                    

Total average separate account assets

   $ 43,191       $ 45,105         (4 %)    $ 45,194       $ 45,664         (1 %) 
                                                    

Liquidation Portfolios1

   $ 11,313       $ 13,370         (15 %)    $ 11,797       $ 4,994         136
                                                    

Total average managed assets

   $ 338,636       $ 408,148         (17 %)    $ 347,533       $ 411,411         (16 %) 
                                                    

 

1

Liquidation portfolios include portfolios of distressed fixed-income securities and liquidating collateralized debt obligation (CDO) products. In the distressed security category, Federated has been retained by a third party to manage assets through an orderly liquidation process that will generally occur over a multi-year period. In the case of liquidating CDOs, the CDO structure has unwound earlier than expected due to events of default related to certain distressed securities in the portfolio. Management-fee rates earned from these portfolios are significantly different than those of traditional separate account mandates.

 

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Table of Contents

Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

 

Changes in Fixed-Income and Equity Fund Managed Assets

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

   2010     2009     2010     2009  
Fixed-Income Funds         

Beginning assets

   $ 30,651      $ 24,100      $ 28,427      $ 19,321   
                                

Sales

     3,655        4,789        11,775        12,537   

Redemptions

     (2,829     (2,971     (9,393     (6,978
                                

Net sales

     826        1,818        2,382        5,559   

Net exchanges

     20        53        51        101   

Market gains and losses/reinvestments1

     714        989        1,351        1,979   
                                

Ending assets

   $ 32,211      $ 26,960      $ 32,211      $ 26,960   
                                
Equity Funds         

Beginning assets

   $ 19,344      $ 17,966      $ 20,960      $ 17,562   
                                

Sales

     1,639        1,503        4,532        4,005   

Redemptions

     (1,582     (1,377     (5,104     (4,119
                                

Net sales (redemptions)

     57        126        (572     (114

Net exchanges

     (31     (12     (54     (79

Acquisition-related

     0        257        0        257   

Market gains and losses/reinvestments1

     1,955        2,013        991        2,724   
                                

Ending assets

   $ 21,325      $ 20,350      $ 21,325      $ 20,350   
                                

 

1

Reflects approximate changes in the market value of the securities held by the funds, and, to a lesser extent, reinvested dividends, distributions, net investment income and the impact of changes in foreign exchange rates.

 

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Part I, Item 2. Management’s Discussion and Analysis

 

of Financial Condition and Results of Operations (Unaudited)

Changes in Fixed-Income and Equity Separate Account Assets and Liquidation Portfolios

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

   2010     2009     2010     2009  
Fixed-Income Separate Accounts         

Beginning assets

   $ 7,361      $ 4,583      $ 5,360      $ 4,165   
                                

Sales2

     530        —          3,289        —     

Redemptions2

     (244     —          (1,078     —     
                                

Net sales2

     286        188        2,211        269   

Market gains and losses/reinvestments3

     316        308        392        645   
                                

Ending assets

   $ 7,963      $ 5,079      $ 7,963      $ 5,079   
                                
Equity Separate Accounts         

Beginning assets

   $ 7,470      $ 8,245      $ 8,713      $ 9,099   
                                

Sales2

     522        —          1,225        —     

Redemptions2

     (975     —          (2,389     —     
                                

Net redemptions2

     (453     (281     (1,164     (1,096

Net exchanges

     9        20        31        70   

Acquisition-related

     0        (257     0        (257

Market gains and losses/reinvestments3

     782        1,047        228        958   
                                

Ending assets

   $ 7,808      $ 8,774      $ 7,808      $ 8,774   
                                
Liquidation Portfolios         

Beginning assets

   $ 11,491      $ 556      $ 12,596      $ 1,505   
                                

Sales2

     3        —          10        —     

Redemptions2

     (423     —          (1,535     —     
                                

Net (redemptions) sales2

     (420     12,516        (1,525     11,563   

Market gains and losses/reinvestments3

     0        1        0        5   
                                

Ending assets

   $ 11,071      $ 13,073      $ 11,071      $ 13,073   
                                

 

2

For certain accounts, Sales, Redemptions or Net sales/redemptions are calculated as the remaining difference between beginning and ending assets after the calculation of Market gains and losses/reinvestments. Sales and Redemptions data was not reported prior to 2010, therefore some historical data is not available.

3

Reflects approximate changes in the market value of the securities held in the portfolios, and, to a lesser extent, reinvested dividends, distributions, net investment income and the impact of changes in foreign exchange rates.

 

29


Table of Contents

Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

 

Changes in Federated’s average asset mix period-over-period across both asset and product types have a direct impact on Federated’s operating income. Asset mix impacts Federated’s total revenue due to the difference in the fee rates per invested dollar earned on each asset and product type. Equity products generally have a higher management-fee rate than fixed-income products, money market products and liquidation portfolios. Likewise, mutual fund products typically have a higher management-fee rate than Separate Accounts. Similarly, traditional separate accounts typically have a higher management-fee rate than liquidation portfolios. Additionally, certain components of distribution expense can vary depending upon the asset type, distribution channel and/or the size of the customer relationship. Federated generally pays out a larger portion of the revenue earned from managed assets in money market funds than managed assets in equity or fixed-income funds. The following table presents the relative composition of average managed assets and the percent of total revenue derived from each asset type for the nine months ended September 30:

 

     Percent of Total Average Managed Assets     Percent of Total Revenue  
   2010     2009     2010     2009  
By Asset Class         

Money market assets

     78     86     50     67

Fixed-income assets

     11     7     18     11

Equity assets

     8     6     31     21

Liquidation portfolios

     3     1     —          —     

Other activities

     N/A        N/A        1     1
                                
By Product Type         

Funds:

        

Money market assets

     69     78     49     66

Fixed-income assets

     9     6     17     10

Equity assets

     6     4     27     18

Separate Accounts:

        

Money market assets

     9     8     1     1

Fixed-income assets

     2     1     1     1

Equity assets

     2     2     4     3

Liquidation Portfolios

     3     1     —          —     

Other activities

     N/A        N/A        1     1
                                

Total managed assets represent the balance of assets under management at a point in time. By contrast, average managed assets represent the average balance of assets under management during a period of time. Because substantially all revenue and certain components of distribution expense are generally calculated daily based on assets under management, changes in average managed assets are typically a key indicator of changes in revenue earned and asset-based expenses incurred during the same period.

September 30, 2010 period-end managed assets decreased 13% over period-end managed assets at September 30, 2009 and average managed assets for the three- and nine-month periods ended September 30, 2010 decreased 17% and 16%, respectively, over average managed assets for the same periods in 2009 primarily as a result of decreases in money market assets, partially offset by increases in fixed-income assets. Period-end money market assets at September 30, 2010 decreased 18% as compared to September 30, 2009. Average money market assets decreased 23% and 24% for the three- and nine-month periods ended September 30, 2010 as compared to the same periods in 2009.

Period-end fixed-income assets at September 30, 2010 increased 25% as compared to September 30, 2009 and average fixed-income assets for the three- and nine-month periods ended September 30, 2010, increased 29% and 35%, respectively, as compared to the same periods in 2009 primarily due to positive net sales and, to a lesser extent, market appreciation. Period-end equity assets at September 30, 2010 remained flat as compared to September 30, 2009 and average equity assets for the three- and nine-month periods ended September 30, 2010 increased 1% and 12%, respectively, as compared to the same periods in 2009 primarily due to market appreciation. As expected, liquidation portfolios at September 30, 2010 decreased 15% as compared to September 30, 2009 and average assets in liquidation portfolios decreased 15% for the three-month period ended September 30, 2010 as compared to the same period in 2009 due to the gradual liquidation of the portfolio. Average assets in liquidation portfolios increased significantly for the nine-month period ended September 30, 2010 as compared to the

 

30


Table of Contents

Management’s Discussion and Analysis (continued)

 

of Financial Condition and Results of Operations (Unaudited)

 

same period of 2009 primarily due to the selection of Federated to advise a multi-billion-dollar portfolio in the third quarter 2009.

Results of Operations

Revenue. Revenue for the three- and nine-month periods ended September 30 is set forth in the following table:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

   2010      2009      Change     Percent
Change
    2010      2009      Change     Percent
Change
 

Revenue from managed assets

   $ 240.3       $ 291.9       $ (51.6     (18 %)    $ 700.8       $ 906.2       $ (205.4     (23 %) 

Revenue from sources other than managed assets

     1.9         1.7         0.2        12     5.8         4.9         0.9        18
                                                                    

Total revenue

   $ 242.2       $ 293.6       $ (51.4     (18 %)    $ 706.6       $ 911.1         (204.5     (22 %) 
                                                                    

Revenue from managed assets decreased $51.6 million for the three-month period ended September 30, 2010 as compared to the same period in 2009 primarily due to a decrease of $42.9 million resulting from a decrease in average money market managed assets and an increase of $17.3 million in voluntary fee waivers by certain money market funds in order to maintain positive or zero net yields. See Business Developments - Continuing Disruption in Global Financial Markets for additional information on the fee waivers to maintain positive or zero net yields along with the related offsetting reduction in expense and the net impact on operating income. The decrease in revenue was partially offset by an increase in revenue of $8.8 million due to an increase in average fixed-income managed assets and an increase of $2.1 million due to an increase average equity managed assets.

Revenue from managed assets decreased $205.4 million for the nine-month period ended September 30, 2010 as compared to the same period in 2009 primarily due to a decrease of $149.8 million resulting from a decrease in average money market managed assets and an increase of $118.5 million in voluntary fee waivers by certain money market funds in order to maintain positive or zero net yields. The decrease in revenue was partially offset by an increase in revenue of $34.3 million due to an increase in average fixed-income managed assets and an increase of $29.2 million due to an increase average equity managed assets.

For the nine-month period ended September 30, 2010, Federated’s ratio of revenue from managed assets to average managed assets was 0.27% as compared to 0.29% for the same period of 2009. The decrease in the rate was primarily due to the significant increase in voluntary fee waivers to maintain positive or zero net yields.

Operating Expenses. Operating expenses are set forth in the following table:

 

      Three Months Ended
September 30,
    Nine Months Ended
September 30,
 

(in millions)

   2010      2009      Change     Percent
Change
    2010      2009      Change     Percent
Change
 

Distribution

   $ 68.8       $ 95.9       $ (27.1     (28 %)    $ 190.1       $ 333.3       $ (143.2     (43 %) 

Compensation and related

     61.4         62.2         (0.8     (1 %)      186.5         192.1         (5.6     (3 %) 

Professional service fees

     9.4         10.1         (0.7     (7 %)      9.6         29.9         (20.3     (68 %) 

Intangible asset impairment and amortization

     3.4